How To Short A Bank Stock Despite A Short-Selling Ban

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As the market freaks out over Europe's banks, Europe's financial regulators have enacted a short-selling ban on bank stocks. The AMF, the French stock market regulator, just announced it would extend the ban, which applies to financial firms, which are: the April Group, Axa, BNP Paribas, CIC, CNP Assurances, Crédit Agricole, Euler Hermès, Natixis, Paris Ré, Scor and Société Générale.

There's a good deal of evidence that short-selling bans increase volatility and are bad for the market.

But more importantly, it's easy as pie to short a bank stock despite a short selling ban: you take an index that includes the bank; you build a synthetic index that includes every stock except the bank, and long that, and short the index that includes the bank. The synthetic index and the actual index cancel each other out and the trade works like a bank short.

We were told the tip by a trader we know, but it's really not rocket science. When we learned of this, we asked our wife, who has an economics degree but doesn't work in finance, "How would you short a stock if you couldn't short it?" and it took her all of five seconds to figure it out. (Yes, she's smarter than us.)

So in case you didn't already, now you know. It's easy as pie to short a bank stock whose stock in theory "can't be" shorted.

NOTE: We're certainly not advocating doing this or vouching for its legality. It might be illegal to do it. But it's certainly possible, and it's almost a given that several clever traders are doing it right now. Which tells us something about the usefulness of short-selling bans.